The 1% rule is a guideline used in real estate investing when evaluating potential rental properties. According to the 1% rule, a property's monthly rental income should be at least 1% of the purchase price.
The goal here is to narrow down the field of investment properties to those most likely to produce sufficient positive cash flow after covering expenses like the monthly mortgage payment and providing sufficient cushion for vacancies or unexpected maintenance items.
How do I use the 1% rule?
To evaluate whether a prospective real estate investment satisfies the 1% rule, multiply the purchase price by 0.01 to determine the minimum monthly rent. For example, if you can purchase a property for $100,000, the 1% rule says that you should only buy it if it will generate a minimum of $1,000 in monthly rent.
You can also use the 1% rule to work backward and determine how much you should be willing to pay for a particular property in order to generate sufficient monthly cash flow. This can be a good method to use, especially if the property is currently rented and you have an actual gross rental income figure to use. In this case, multiply the property's monthly rent earned by 100 to determine your maximum purchase price.
What are the shortcomings of the 1% rule?
The 1% rule is intended as a guideline, not a firm line in the sand. It is less effective when it comes to properties that are likely to have higher-than-average maintenance expenses or vacancy rates or that have other unusually high ownership costs. The 1% rule should be used as a part of a thorough analysis, not as the sole method of evaluating real estate investments.
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